Scroll to the bottom of this article to see the glossary of terms.
They say, “The best time to invest is yesterday. The second-best time is now.” It’s never too late to take charge of your financial future by being well informed about the fundamentals of money management.
A report recently revealed that over half the U.S. population lacks rudimentary financial literacy. Separate studies have indicated that even ultra-high-net-worth individuals (UHNWI’s) aren’t immune to feelings of economic insecurity. Indeed, one survey showed that increased levels of wealth actually correlate with a reduced likelihood of having put adequate financial provisions in place.
With that in mind, we recently sat down with Meghan Grainer, Geller Director and Senior Client Relationship Manager, for a timely educational primer on the ABC’s of investing, preserving, and growing one’s wealth.
Meghan, before we drill down into specifics, let’s first begin with the big picture overview from 30,000 feet. As you work with multi-generational families on developing a cohesive and holistic financial plan, what are some of the key initial investment discussions you typically engage in?
As advisors, the first step involves constructing an overarching financial plan and working with clients to map out their short, medium, and long-term goals and objectives. This detailed process enables us to identify what gaps, if any, exist in their financial ecosystem. In doing so, the aim is to provide guidance, recommendations, and—where appropriate—enlist the services of subject matter experts. Ultimately, the financial plan should be the main driver for portfolio construction and long-term asset allocation conversations.
Next, it’s important for me to understand the risk each client is able and willing to take. Some of our clients who have substantial sums of money are relatively risk-averse and seek conservative portfolios. Others, by contrast, are more aggressive in their investment approach. Every client and family have different needs and priorities. The respective risk tolerance may differ depending on what chapter of life they are currently in. These cycles are similar to a bell curve across a lifespan. They include the asset accumulation phase (prime earning years), wealth preservation mode (generally aged 50’s to 60’s), and subsequent spending or gifting stage often associated with retirement.
Our objective—and that of any wealth advisor—is to construct a portfolio that aligns with a client’s cash flow and risk tolerance alike. We will help to formulate a unique investment policy statement (IPS) that adequately reflects both.
Can you elaborate a bit on the Investment Policy Statement, and why it is such a key cornerstone of client interactions?
The IPS is effectively a roadmap outlining parameters for the overall portfolio. It’s a document that identifies a framework for strategic asset allocation, any liquidity constraints the client should be cognizant of, and potential tax considerations. The IPS also lists specific investments or limitations that the client wants to be mandated.
When you are engaging in an investment advisory relationship, the IPS that clients sign essentially stipulates their asset allocation strategy. For example, it may say that they want to invest in a portfolio that is 70% in equities (stocks) and 30% in fixed income (bonds), for instance.
“Asset allocation” is something you’ve already mentioned multiple times. What is it, exactly, and why is it so important?
You’ll hear this concept come up a lot in meetings with your wealth advisor. Asset allocation refers to where each of your financial holdings live within your investment portfolio, whether they are invested in equities, fixed income, cash, alternatives, and so on.
There is no cookie cutter, one-size-fits-all approach for optimal portfolio construction. It all depends on a multitude of personal factors including the client’s time horizon, risk profile, investment objective, and liquidity status. Ultimately, the advisor will discuss a risk and reward with each client to ascertain the asset allocation strategy that is most appropriate.
It’s an iterative process and, as previously pointed out, the level of risk that a client is comfortable with may evolve over time. Therefore, in constructing a portfolio, you essentially have to meet the client where they are at any given point. That’s where the wealth advisor comes in, informing each individual about the risk versus reward tradeoff inherent in each chosen allocation.
I would add that education also plays a vital role here. All clients should have a general understanding of what their budget is, so that they stay within their means and avoid overspending. Other key considerations include tax factors—if someone is living off of their portfolio and regularly require income, then it should be more conservatively invested—and whether or not they are charitably inclined.
Financial jargon is sometimes a little intimidating, filled as it frequently is with ten-dollar words. “Diversification”, a close cousin of “asset allocation”, is another idea we hear a lot about in the world of investing.
It can be quite complicated and esoteric—Harry Markowitz even won a Nobel Prize in economics for his portfolio theory expounding upon the benefits of diversification. Yet, in essence, it’s fundamentally a fairly simple concept, correct?
Absolutely. Ultimately, diversification comes back to the old expression “Don’t put all your eggs in one basket.” While this sounds very basic, over time it really does pay to have your money spread around different asset classes and investments. This can help to mitigate risk and optimize returns. For example, one segment of the market may be doing very well, before suddenly embarking on a course correction. Being diversified by holding a cross section of uncorrelated assets (those which tend not to move in tandem) gives you a better opportunity of participating on the upside, while also protecting downside risk.
Having an appropriate mix of investments may include stocks, bonds, and cash. Diversification can also apply within each asset class. If you are looking to equities as a hedge against inflation, for instance, it’s imperative to select a combination of growth, value, small cap, large cap, domestic, and international companies.
By not being adequately diversified, your portfolio is also more vulnerable to concentration risk due to overexposure to a single investment or market sector
One way for UHNWI’s to potentially diversify their portfolios beyond stocks, bonds, and cash is with more complex alternative investments. Lately, this sector seems to be attracting increased attention. Could you talk us through what it entails?
Alternative investments include private equity, hedge funds, and real estate. These represent another type of asset class, one which may be suitable for those clients who meet qualifying criteria and are more willing to embrace risk. Typically, such assets are less likely to move in lockstep with the public equity markets. In other words, if the stock market as a whole is down, there is a reduced probability that private markets will decline by as much or indeed at all. This relative insulation can make them an attractive investment within an overall portfolio.
Private credit, co-investments, secondaries, and venture capital are other examples of alternative investments into which a client may choose to allocate resources. Depending upon the specific strategy, investing in early-stage seed companies, for instance, may act as an effective hedge against broader market volatility.
That said, alternative investments aren’t necessarily appropriate for everyone. Most private equity investments, assuming they are traditional private equity funds, have a life cycle of ten years. Due to such comparative illiquidity, it is important that investors are aware that this portion of their money is essentially off limits for a relatively long time. In addition to liquidity restraints, investors should be aware of the limited transparency and higher fees for alternative investments. Certain hedge funds, meanwhile, may contain lock-up restrictions.
As ever, no one generic approach works for everyone. That’s why it is crucial to work in close consultation with your wealth advisor in devising an overall action plan that works best for your personal situation and goals.
Let’s pivot from definitions to demographics for a moment. If the ‘Fearless Girl’ statue outside the New York Stock Exchange is any indication, a large part of the future of high finance is female. Women now control over a third of household assets, valued in the trillions of dollars.
Yet, as you have previously pointed out, they still lag behind men in both retirement savings and financial literacy. Can you address the importance of wealth education in helping UHNW women empower themselves?
In our experience, women are sometimes reluctant to discuss topics such as wealth transfer, how to read a balance sheet, insurance policies, and the like. Our aim is to encourage female clients to have a voice at the table and feel free to speak up. By doing that—ideally even before they come into sizeable wealth—talking about financial subjects suddenly becomes a lot less uncomfortable.
The process is ultimately all about building knowledge and awareness. It’s essential to know exactly where your assets are, how to access them, and ensure your risk profile and investment objective are precisely aligned. ‘Wealth longevity,’ a crucial component of the title to this article, is particularly pertinent to women. Given that they tend to outlive men on average, carefully constructing a portfolio to ensure their money lasts a lifetime is especially important.
Your prior answer alluded to a ‘wealth transfer.’ There is indeed a major passing of the baton set to occur, with Cerulli Associates estimating that some $84 trillion in assets is due to be passed down over the next 20 years.
Any advice here for individuals coming into new wealth via a business transaction or inheritance, members of the rising generation looking to forge their own paths, or those who are just starting to take charge of their financial life? How can they avoid the ‘more money, more problems’ curse, or what we in the UHNW world often refer to as third generation ‘shirtsleeves to shirtsleeves’ syndrome?
We talk about that stat a lot with our second and third-generation clients who will be bequeathed significant wealth over the next several years. Basic financial education as relates to budgeting, cash flow, outlining what their goals and dreams are—these are all important factors. It’s vital that clients don’t spend the money all at once as it has to last their entire life, especially if they are not working.
As advisors, our guiding ethos is to ensure that the money is always being invested appropriately. A couple of components are especially necessary when one comes into newly acquired wealth. Firstly, ascertaining that the ownership structure of the funds is correct. For instance, does it make the most sense for the assets to be in your personal name, a family limited partnership, or revocable trust? Secondly, ensuring that you surround yourself with really strong subject matter experts, including your wealth advisor, attorney, tax counsel, and so forth.
Any concluding thoughts, Meghan?
At the end of the day, knowledge is power. Financial education and awareness are key. Clients should be actively involved in the decision-making process, working in tandem with their wealth advisor to create an optimal mix of assets that best suits their specific needs and objectives.
There is no universal template that applies to all investors. Building a bespoke portfolio takes time, care, and thoughtfulness. Ultimately, your advisor can help create a best-in-class strategy to preserve and grow your hard-earned money.
Glossary of Terms
Asset Class is a group of investments that share similar characteristics, behave similarly in the market, and are subject to the same laws and regulations. In investment management, asset classes are used to categorize different types of investments based on their risk, return, and liquidity characteristics.
Common asset classes include:
- Stocks (also known as Equities): These represent ownership in a company and provide potential for growth through capital appreciation and dividends.
- Bonds (Fixed Income): These are loans made to governments or corporations that pay regular interest and return the principal at maturity. They are generally considered lower risk than stocks.
- Cash and Cash Equivalents: These include assets that are easily convertible to cash, like savings accounts or short-term government bonds, and are the least risky but also offer the lowest returns.
- Real Estate: Investment in property or real estate investment trusts (REITs), which can generate income through rent and appreciate in value over time.
- Commodities: Physical assets like gold, oil, or agricultural products that can be traded in the market.
- Alternative Investments: These include assets like private equity, hedge funds, or collectibles, which often have higher risks and potential returns and are less liquid than traditional asset classes.
A Co-Investment in private equity is when an investor partners with a private equity firm to invest directly in a company. This usually occurs alongside the firm’s main investment fund but involves a separate, often smaller, capital commitment.
In a co-investment, the private equity firm typically leads the investment process, including sourcing the deal, conducting due diligence, and managing the investment. The co-investor, which could be an institutional investor or high-net-worth individual, benefits from the private equity firm’s expertise and access to deals but invests directly in the company alongside the firm.
Co-investments are attractive because they often come with lower fees than traditional private equity fund investments and allow investors to have more control over their investment decisions. However, they also involve higher risks since they usually involve investing in a single company rather than a diversified fund.
A Family Limited Partnership (FLP) is a type of legal entity commonly used in estate planning to help families manage and protect their wealth. In a FLP, family members pool their assets into the partnership, which is then divided into general and limited partnership interests.
- General Partners have control over the management and operations of the partnership/legal entity. They make decisions about the assets and assume the associated liabilities.
- Limited Partners typically have an ownership interest in the partnership but do not have control over its management. Their liability is limited to the amount of their investment.
The primary benefits of an FLP in estate planning include:
- Asset Protection: Assets held in an FLP may be better protected from creditors and lawsuits.
- Estate Tax Planning: By transferring ownership interests in the FLP to family members (often at a discounted value due to the lack of control and marketability of the interests), the overall value of the taxable estate can be reduced, potentially lowering estate taxes.
- Family Control: The general partners, often the parents or older generation, retain control over the assets and decision-making, while gradually transferring wealth to the younger generation.
- Income Distribution: The Family Limited Partnership structure allows for flexible distribution of income among family members, which can be useful for tax planning.
Overall, a Family Limited Partnership is a tool for families to manage wealth, transfer assets to future generations, and potentially reduce estate taxes while maintaining control over the assets.
Fixed Income: An income from a pension or an investment that is set at a particular number and does not vary or rise with the rate of inflation—they are designed to pay a set level of income to investors, usually in the form of fixed interest or dividends.
A Hedge Fund is a type of investment fund that pools capital from multiple investors to invest in a variety of assets, often with the goal of generating high returns. Hedge funds are known for their flexibility in investment strategies and their ability to use more complex and risky techniques compared to traditional investment funds like mutual funds.
Key characteristics of hedge funds include:
- Diverse Investment Strategies: Hedge funds can invest in a wide range of assets, including stocks, bonds, commodities, currencies, and derivatives. They often use strategies like short selling (betting that the price of an asset will go down), leverage (borrowing money to increase the size of investments), and arbitrage (taking advantage of price differences between markets).
- Active Management: Hedge fund managers actively make decisions about buying and selling assets, aiming to outperform the market or achieve specific investment goals, such as absolute returns regardless of market conditions.
- Less Regulation: Hedge funds are typically less regulated than other types of investment funds, which gives them more freedom in how they invest but also means they are often only available to accredited investors, such as high-net-worth individuals or institutions.
- Performance-based Fees: Hedge funds usually charge a management fee and a performance fee, the latter being a percentage of the fund’s profits. This structure incentivizes managers to achieve higher returns.
- Risk and Reward: Hedge funds can offer high potential returns, but they also come with higher risks due to their use of complex strategies and leverage.
Overall, hedge funds are designed for sophisticated investors seeking potentially higher returns, often with a higher tolerance for risk.
Liquidate: Converting assets into cash or equivalents by selling them in the marketplace and distributing the proceeds to stakeholders.
Liquidity: The availability of liquid assets (cash).
Private Credit refers to loans or debt investments that are made by non-bank lenders, typically to companies, and are not traded on public markets. Unlike traditional loans from banks or bonds issued in public markets, private credit involves direct lending to businesses, often by private equity firms, hedge funds, or specialized private credit funds.
Key characteristics of private credit include:
- Direct Lending: Private credit typically involves direct loans to companies, which can include senior loans, mezzanine debt, or other types of financing. These loans are usually negotiated directly between the lender and the borrower.
- Illiquidity: Since private credit is not traded on public markets, it is considered less liquid, meaning it can be more difficult to quickly sell or transfer these loans if needed.
- Higher Yields: Due to the higher risk and illiquidity, private credit investments often offer higher yields (returns) compared to traditional fixed-income investments like publicly traded bonds.
- Customizable Terms: The terms of private credit agreements are often more flexible and can be tailored to the specific needs of the borrower and lender, including the interest rate, repayment schedule, and covenants.
- Use in Portfolios: Private credit can provide diversification in investment portfolios, offering a source of income that is less correlated with public markets, which can be particularly valuable during periods of market volatility.
Private credit is an alternative investment strategy that allows investors to participate in lending to companies, potentially earning higher returns, but with a higher level of risk and less liquidity compared to traditional debt investments.
Private Equity is a type of investment that involves buying and managing private companies or taking public companies private, with the goal of improving their value and eventually selling them for a profit. Unlike public equity, which involves buying shares of companies listed on stock exchanges, private equity deals with investments in companies that are not publicly traded.
Key aspects of private equity include:
- Long-Term Investment: Private equity investments are typically long-term, often lasting several years. During this period, private equity firms work to increase the value of the company through various strategies, such as improving operations, expanding the business, or restructuring the company.
- Active Management: Private equity firms often take an active role in managing the companies they invest in. This can include making significant strategic decisions, changing the management team, or guiding the company through major changes to boost performance.
- Types of Private Equity: Private equity encompasses various strategies, including:
- Buyouts: Acquiring a controlling interest in a company, often with the help of borrowed funds (leveraged buyouts).
- Growth Capital: Investing in more mature companies that need capital to expand or restructure operations.
- Venture Capital: Providing early-stage funding to startups and young companies with high growth potential.
- Illiquidity: Private equity investments are generally illiquid, meaning investors cannot easily sell their stake before the investment period ends. This makes private equity suitable for investors with a longer time horizon and a higher tolerance for illiquidity.
- High Potential Returns and Risks: Private equity can offer high returns if the invested companies grow significantly in value. However, it also comes with higher risks compared to traditional public market investments, due to the lack of liquidity and the challenges in managing and growing private companies.
Private equity is a significant part of the financial markets, providing capital to companies and playing a vital role in their growth and development. It’s typically accessible to institutional investors or high-net-worth individuals due to its complexity and risk profile.
A Revocable Trust, also known as a Living Trust, is a legal arrangement in which a person (the grantor or trustor) transfers ownership of their assets into a trust, but retains the ability to change or revoke the trust during their lifetime. The grantor typically acts as the trustee (or appoints someone else) and manages the trust assets.
Key features of a revocable trust include:
- Control and Flexibility: The grantor can modify, amend, or terminate the trust at any time, as long as they are mentally competent. This provides flexibility in managing assets and making changes as circumstances evolve.
- Avoidance of Probate: One of the main advantages of a revocable trust is that it allows the assets in the trust to bypass the probate process when the grantor passes away. This can save time, reduce legal fees, and provide more privacy for the family.
- Management During Incapacity: If the grantor becomes incapacitated, the successor trustee (appointed in the trust document) can step in and manage the trust assets on behalf of the grantor, ensuring continuous management of the estate.
- Estate Planning Tool: A revocable trust is commonly used in estate planning to manage and distribute assets according to the grantor’s wishes after their death. It can also be used to provide for minor children, special needs beneficiaries, or other specific purposes.
- No Immediate Tax Benefits: Unlike some other trusts, a revocable trust does not provide immediate tax benefits because the assets are still considered part of the grantor’s estate. However, it can be structured to help with estate tax planning.
Overall, a revocable trust is a versatile tool in estate planning that allows individuals to manage their assets, plan for incapacity, and ensure a smoother transfer of assets to beneficiaries after death.
Secondaries in private equity investing refer to the buying and selling of pre-existing investor commitments to private equity funds or direct interests in companies. This market allows investors to purchase or sell stakes in private equity investments that were originally made by someone else, often at a discount.
Key aspects of secondaries include:
- Liquidity for Investors: Private equity investments are typically long-term and illiquid, meaning investors’ capital is locked up for several years. The secondary market provides an opportunity for investors to exit their positions before the fund’s life cycle ends, offering liquidity that is otherwise hard to come by in private equity.
- Discounted Purchases: Buyers in the secondary market often purchase these interests at a discount to the net asset value (NAV) of the underlying assets. This discount compensates for the illiquidity and potential uncertainty about the future performance of the assets.
- Diversification: Investors can use secondaries to quickly build a diversified private equity portfolio, acquiring interests across different funds, strategies, and vintages (the year a fund was established) without having to commit to new funds.
- Types of Secondaries: The secondary market includes:
- LP Secondaries: Transactions where limited partners (LPs) sell their fund commitments to other investors.
- GP-led Secondaries: Transactions where the general partner (GP) initiates a process to sell or restructure the fund’s assets, often to extend the holding period or provide liquidity to investors.
- Risk and Opportunity: While secondaries offer potential for attractive returns, they also come with risks, such as the challenge of accurately valuing the assets and understanding the future performance prospects of the underlying investments.
Secondaries provide flexibility and opportunities for both buyers and sellers in the private equity market, making it an important segment for managing liquidity and investment strategies.
Venture Capital (VC) is a type of private equity investment that focuses on providing funding to early-stage, high-potential companies, often startups, that have innovative ideas or products but lack the financial resources to grow on their own. Venture capitalists invest in these companies in exchange for equity, or an ownership stake, with the expectation of significant returns if the company succeeds.
Key aspects of venture capital include:
- Early-stage Funding: Venture capital is typically provided during the early stages of a company’s development, such as seed, startup, or growth stages. These companies are often in technology, biotech, or other high-growth industries.
- High Risk, High Reward: Venture capital investments are risky because they are made in companies that are not yet established and may fail. However, if the company succeeds, the returns can be substantial, often many times the original investment.
- Active Involvement: Venture capitalists often take an active role in the companies they invest in, providing guidance, strategic advice, and access to networks to help the company grow. They may also take seats on the company’s board of directors.
- Exit Strategies: Venture capitalists seek to exit their investments after a few years, typically through an initial public offering (IPO) of the company’s stock or by selling the company to another firm. This is when they realize their returns.
- Venture Capital Funds: Investors pool their money into venture capital funds managed by professional venture capital firms. These firms then use the pooled capital to invest in a portfolio of startups, spreading out risk across multiple investments.
Venture capital plays a crucial role in driving innovation and economic growth by supporting young companies that have the potential to become major industry players.
